Last 20 years of UK-EU trade data show Clean Brexit is safest course. Part 2

Export Categories 1–5

In 2017, manufacturing contributed 89% of all UK goods exports, down only fractionally from 91% in 1998. But the composition of UK exports has changed dramatically. Since 1998, exports of computers and electronics have collapsed, and exports to EU – where the collapse occurred – are now worth just 37% of their 1998 value. The big growth in UK exports since 1998 is in motor vehicles (worth £44.9 billion in 2017) , although this growth is predominantly due to sales of luxury vehicles into non-EU markets with whom UK trades on WTO terms. What's more, the success of UK's other two high-growth sectors – aerospace and pharmaceuticals – is due to factors outside the workings of the Customs Union and Single Market.

This section will now step through each of UK's top-ten export sectors, in order of value to UK in 2017. It will track the successes and failures since 1998, and question to what degree each sector depends on frictionless trade with the EU, or the openness of world markets.

Note: All data in this section was published by the ONS in March 2018. Compiled data and calculations are available here. Note, ONS revised its historic data in September, so most values have changed fractionally. The principal effect was to reduce EU export growth rates. All time series data have been adjusted for inflation using an ONS trade deflator based on 2015 prices. Growth calculations use three-year averages at the start and end of each time period.

  1. Motor vehicles and parts

The strange failure of UK industry to benefit from the Customs Union is most apparent in UK’s trade in vehicles. Worth £45 billion in exports in 2017, this is the UK’s most-important traded sector, accounting for 14.9% of all manufacturing exports in 2017. What’s more, vehicles are becoming more important to UK trade. The share of motor vehicles and parts in UK manufacturing exports has risen from 10.7% in 1998, rising quickest during the past decade.

But UK’s automotive renaissance owes nothing to the EU. Conducted predominantly on WTO terms (author estimate of at least 73%)* UK car exports to countries outside the EU have grown by 7.9% p.a. since 1998, while exports to EU have stagnated. Adjusting for inflation and taking a three-year average at the beginning and end of the last two decades, exports to EU have grown by just 0.4% per year. Even this metric is generous, since most of the growth occurred between 1998 and 2007. Average yearly exports to the EU were worth less in 2007–2018 than in 1998–2007. Exports to EU in 2017 (a good year) have still not surpassed the level achieved in 2007, while exports outside the EU have more than doubled.

In blunt terms, this means that over the past 20 years, export growth for the UK motor-vehicle has relied solely on non-EU markets. The source of most growth is clear because a leap in exports from 2010 coincides with the resurgence of Coventry-based Jaguar Land-Rover (JLR). That company has enjoyed particular success in global markets in which UK trade on WTO terms – especially China and the United States (each of which typically contribute 20% of annual sales). What's more, these markets are also critical to the renaissance of UK's luxury or premium automotive brands - such as Bentley, Rolls-Royce, Aston Martin and (in part) BMW’s Mini - in contrast to Nissan, Toyota and Honda which principally export to the EU.

Far from providing a springboard into the EU, the Single Market has encouraged production to shift from UK to continental Europe, whence imports have grown at a steady 3.6% p.a. since 1998. The result is plain on UK roads. The UK’s top selling cars are now almost all imported from the EU: Ford Fiestas from Cologne and Almussafes in Spain; Vauxhall’s Corsa, made under licence by Opel at Eisenach; and the Ford Focus built in Germany at Saarlouis.

But here’s the danger: this offshoring trend is now edging in UK’s world-class premium motor manufacturing, even though UK-built cars are highly successful on global markets. JLR has just completed a £1 billion factory in Slovakia to which production of the Land Rover Discovery will be moved during 2017[1]. BMW-owned Mini now makes 149,000 of its 360,000-annual production at Graz in Austria under contract with Magna Steyr. And it’s at this same Magna Steyr plant that JLR’s new E-Pace and I-Pace models will enter production in 2018.

Thus, the net effect of UK participation in the Customs Union since 1998 has been to encourage investment away from UK to continental Europe. The unarguable proof that this is the dominant trend is the rise in UK’s EU deficit in motor-vehicles and parts from £7.9 bn in 1998 to £28 bn today, coupled with stagnant exports. This is easily UK’s worst trade-sector deficit, and the deficit alone is worth more than UK’s entire financial services exports to the EU.

But here’s the vital point. With imports from the EU growing only slightly slower than non-EU imports, the effect of the Customs Union has been to retain UK as something approaching a captive market for EU motor manufacturing. Today, 83.8% of UK’s motor vehicle imports arrive from the EU, down slightly from 85.1% twenty years ago. This is nothing like the precipitous decline in the EU as a destination for UK-built cars, parts and engines, which has dropped from 73.5% in 1998 to just 44.7% in 2017. And take note: this pattern is repeated – in a slightly less extreme form – in almost all of UK’s goods-export sectors.

The question then arises: what’s the reason? It may simply be that, as with machinery, the UK is simply not competitive with EU companies, and specifically German-owned motor-vehicle companies. So, the route cause may be that UK is being comprehensively outcompeted in the EU: unfortunate, but a fact of commercial life. But the Volkswagen emissions scandal highlights another reason which may be contributing to UK’s curious inability to increase exports within Customs Union and Single Market.

In October 2013, JLR announced it would cease production of the popular Defender model, and specifically cited EU emissions rules as the reason[2]. From this act it is reasonable to assume that JLR complies with EU emissions rules, and that compliance adds cost and decreases the competitiveness of its products. And yet, it’s now clear that Europe’s biggest car-maker, VW, deliberately chose not to comply with emissions rules, and has accrued competitive advantage thereby. What’s more, this lack of compliance was uncovered not by the EU, but by private industry researchers in the U.S.

This case raises two awkward but critical points involving UK’s relative export failure in the EU. First, that the EU itself cannot enforce the regulations created within the Single Market, because it relies on member states to uncover non-compliance. This is a fundamental weakness of the Single Market, because it requires member states to act against their own industrial interest. If UK enforcement is stricter than elsewhere, then UK companies are not playing on a level field.

Second, if non-compliance is practiced at the pinnacle of German industry, then analysts must ask whether it is endemic across Europe. Twenty years ago, it was a common complaint in the UK Midlands that UK companies abided by Single Market regulations, while companies elsewhere in Europe did not. Following the VW emissions scandal, this complaint is a proven fact, however uncomfortable. As a general cause of UK un-competitiveness within the EU, it may be major, incidental or totally irrelevant. But it’s now unarguable that non-compliance with Single Market regulation by UK’s competitors in the EU has compromised UK exports. This includes reducing UK exports to non-EU countries, since the Defender’s export market was principally outside the EU.

Regardless of the cause, UK must face up to some uncomfortable questions. Why should UK try to replicate a seamless, frictionless trade arrangement with the EU that doesn’t stimulate exports but does lead to off-shoring of production and a consequent enormous deficit? Why should UK shy away from trading purely on WTO terms in motor vehicles, when that’s precisely what’s quadrupled exports over 20 years, delivering a thumping, £15.3 billion surplus for UK trade.

More pointedly: is tariff-free trade in motor-vehicles with EU really a valuable asset for UK if the results after 20 years compares so poorly with trading on WTO terms? As the graph immediately above shows quite clearly, seamless, tariff-free trade with the EU has accomplished nothing obvious for UK exports in 20 years. It has, however, created a £28 billion deficit, as investment drifts to continental Europe. If this is the proven record of tariff-free trade with the Single Market, then why try to preserve it?

In any case, the single event most likely to impact (negatively) on UK car exports and manufacturing is unrelated to Brexit. The EU-Japan Economic Partnership Agreement, which both parties ratified at the end of 2018, will eliminate tariffs on imports of motor-vehicles into EU from Japan. At one stroke, this removes the competitive advantage and original commercial logic for Nissan, Honda and Toyota to build cars in UK. Whether UK governments will fund sufficient inducements to keep those companies in UK is a question of industrial policy. Nevertheless, any trade analyst worth their salary should have noted that what the EU traded in that agreement was the commercial advantage enjoyed by UK's Japanese car plants, in return for greater access for EU foodstuffs into China.

The bulk of UK's mass-market motor manufacturing is, Deal or No deal, now living on borrowed time.

2. Transport Equipment

In ONS terms, the UK’s second-biggest export category is transport equipment, worth £36.2 billion in 2017. Approximately 94% of the goods in this sector are aerospace-related: 48% – worth £18.2 billion in 2017 – consists of aircraft engines, principally turbo-fans made for civilian airliners by Derby-based Rolls-Royce; a further 44% – worth £16.7 billion ‒ are aircraft of aircraft parts, including wings, made either for Airbus (in Broughton) or Bombardier (Belfast) or military aircraft.

Transport equipment is also one of UK’s fastest-growing manufacturing export sector having grown by 92% in real terms since 1998. This makes aerospace one of UK’s undisputed trade successes. As a proportion of UK’s manufacturing exports, the sector’s contribution has rocketed from 7.8% in 1998 to 12% in 2017. Only pharmaceuticals has increased its share of UK manufacturing at a faster rate.

Tellingly, aerospace is also UK’s most globalised top-ten manufacturing-export industry. Taking an average for the last three years, almost exactly two-third of exports already go to non-EU markets, notably North America, the Middle East and Southeast Asia.

At first glance, the EU appears to have provided a good market for UK exports over the past two years. A 2.7% growth rate per year compares extremely well to the other sectors and is surpassed only by the pharmaceuticals sector. But here the good-news story stalls, because UK’s trade in aerospace gains no commercial advantage from the Customs Union and is only tangentially impacted by the Single Market. Under WTO rules, there are no tariffs on commercial aircraft of aircraft parts — a long standing multilateral agreement signed under the General Agreement on Tariffs and Trade (GATT) in 1980. Neither would UK face tariffs from being outside and trading purely on WTO terms — from EU or anyone else.

Nor does UK industry gain in any commercial sense from the Single Market. Regulation in civil aerospace is undertaken jointly by the Cologne-based European Aviation Safety Agency (EASA) and the UK’s Civil Aviation Authority (CAA). But certification of aircraft and parts (and air-worthiness issues) are in practice a matter of global collaboration, especially in partnership with the US Federal Aviation Administration. With global rules, UK Aerospace companies gain no preferential advantage from being in the European Single Market, because its rules cannot be made to favour EU-made products. In this case, the Single Market is a bureaucratic and commercial convenience, not a source of competitive advantage.

The UK would incur a bureaucratic cost in withdrawing from EASA and transferring all regulatory and safety-inspection duties to the CAA. New, transnational licensing agreements would be required. Certification bodies would need to be re-recognised. And safety checks or inspections might, without a collaboration agreement, require doubling up. In late June, Airbus asserted that its investments in UK – principally wing design and manufacturing at Filton, Bristol and Broughton, North Wales, ‒ would be at risk if the UK exited the EU without a deal. And the value of Airbus work is considerable: £5.9 billion in 2015, which was 90% of UK exports of non-engine aircraft parts to the EU that year.

But UK must be careful not to confuse negotiations over trade policy with the desire to exploit regulatory power for tactical advantage in UK’s exit from the EU. Airbus already sources wing structures from Xian Aircraft Industry Corporation in China for its Tianjin-assembled A320s. Airbus cannot credibly suggest that it must disinvest from wing manufacture in UK because of the failure of UK to sign an all-encompassing Brexit trade agreement, when it is already using China-manufactured wings to produce Airbus models.

Similarly, it would be discriminatory for EASA to refuse regulatory collaboration with a re-empowered UK CAA when it already operates similar international collaboration agreements. These include a standards recognition agreement with the Civil Aviation Authority of Singapore, where Rolls-Royce manufactures titanium fab blades for Trent 700 engines used on Airbus aircraft. It is not credible to assert that UK-based wing manufacturing is dependent on a trade deal with the EU, when the customer in question sources parts from China and Singapore, neither of which currently have an operative free trade agreement with the EU.

Besides, UK participation in Airbus is already underwritten by tax-payer subsidies. UK participation in Airbus is secured via launch aid, which is essentially a tax-payer guarantee on the commercial success of each new model of civil aircraft. The fact that Airbus already receives public subsidies - and the fact that U.S. alternatives are available in most instances of UK defence procurement - mean that at a tactical level, the EU cannot push this argument far for without antagonising one its principal investors, who is simultaneously one of its principal customers. Threats from Airbus are only relevant in so far as they reveal the politicised nature of that particular enterprise.

As with many of the supposed impediments to a No-Deal/WTO scenario, the commercial risk to UK is not from the terms of trade the UK would encounter – the impact of which is long-term, but the politics and power-play of regulatory separation – the impact of which is short-term. If corporations threaten disinvestment for regulatory reasons, or regulatory bodies threaten non-recognition, then that is using regulation not in consumer interests but in pursuit of short-term advantage.

On a different tack, the performance of the UK aerospace sector since 1998 raises interesting questions. How is it that the industrial-engineering sector where UK has achieved its second-highest export growth since 1998 is simultaneously the one where UK gains no material advantage from membership of the Customs Union, and only marginal administrative benefit from the Single Market? Is this coincidence, cause or just an illustration that the UK economy is not positioned to take best advantage of the theoretical benefits of the Customs Union.

But UK’s success in aerospace also indicates where UK’s future interests lie. Currently, the UK’s fastest -growing big industrial export sector is also the one in which trade is already most globalised. Already, 68.2% of all exports go to non-EU countries. This supports one of the arguments made by pro-Brexit free traders: that the faster the UK can re-orient its exports to global markets, the quicker its exports will grow.

Case Study: Europe’s curious indifference UK’s aero-engines

One of the unfortunate traits in UK’s trade with the EU is that where UK does produce world-class goods or services, the EU provides an indifferent market, and the typical benefits of a customs union are inoperative.

Rolls Royce – the power systems and aircraft engine company – is a telling example. Almost uniquely for a UK engineering company, Rolls-Royce is the premier European company in its biggest market – wide-fan turbine aero-engines. Its nearest rival, Safran Aircraft Engines, based in Courcouronnes, France, builds medium-thrust engines in collaboration with the U.S. company, GE, but the two companies do not directly complete, except via consortia.

The global market for powering wide-body airliners such as the Boeing 777 and 787, or Airbus A380 and A350 is usually a straight fight between Rolls-Royce and GE alone, with Pratt & Whitney (also based in the U.S.) occasionally contributing to one side or the other. And it’s this large, turbofan market that dominates UK’s highly valuable, £13 billion exports in aero-engines. This is big money for UK: £13 bn is equivalent of over two-thirds of UK’s entire annual motor-vehicle exports to EU.

In the absence of a direct competitor within the EU, Rolls-Royce might have hoped the EU would be a natural market for its engines. But the reverse has happened. In the past 20 years, exports of aircraft engines to the EU almost halved in real terms, from £2.2 bn to £1.35 billion in 2016. Exports outside the EU, meanwhile, have grown strongly – especially in the last decade, reaching £11.7 bn in 2016. (ONS data for 2017 released in March 2018 showed a peculiar surge in exports, including to EU. In its September release, ONS omitted this subcategory altogether. The author assumes the data up to 2016 is correct).

With the partial exception of Lufthansa, European airlines almost invariably select US-made engines for wide-body airliners. Incidentally, defence procurement follows a similar pattern, unless the procuring nations are part of a project-based European industrial consortium. For example, UK’s Eurofighter (in which UK’s BAE Systems has a 33% stake) has gained not a single European customer outside its consortia home nations, with the minor exception of Austria. Every other NATO country that doesn’t build its own fighters buys American.

In one sense, the reasons for this outcome don’t matter. If European airlines prefer US-made engines for reasons related to industrial collaboration (as is the case with Air France) or even politics, so what? It’s a pity that EU’s instinct for protectionism against the United States stops short at the one industry where UK would greatly benefit. That may or may not be a reflection on the efficacy or spirit of UK input into the EU. But the fact remains, in the biggest single market where a UK company is the undisputed European champion, EU customers prefer US-made products.

However, this example helps illuminate the causes of poor UK export performance – if only in the negative. It is sometimes claimed that the disparity in trade performance between EU and non-EU markets is due to EU countries growing more slowly than markets in the Americas or Asia. But here, in UK’s second biggest goods-exports sector, something else is clearly going on. For whatever reason, EU companies prefer buying US products.

To digress – slightly – most sources[3] put the long-term growth rate of the Euro Area at approximately 1.5% per year. This is a whole percentage point faster than UK’s long-term EU goods-export growth rate, 0.4% — and even that number was flattered by Sterling’s 2017 weakness. So, for reasons that are unconnected with the EU’s slow growth rate – politics, business culture, over-regulation, mis-regulation, or strategic industrial interest – there are major sectors of UK exports that inherently perform badly in the EU markets, and in which the Customs Union and Single Market provide no benefit.

3. Machinery

Number three in UK’s most-important export sectors is machinery—and it’s here that a definite pattern sets in: exports to EU hovering around zero percent growth per year, imports growing strongly, and trade with the non-EU countries sat between the two. A representative of this sector is UK’s JCB, whose factories in Rochester, Cheadle, Rugeley, Uttoxeter, Foston and Wrexham export £1.35 billion of machinery per year.

Despite possessing world-class companies like JCB, the EU has become a stagnant market for UK exporters. Since 1998, the fastest-growing part of UK trade in machinery has been imports from the EU (up 3.4% p.a.) while the worst-performing has been exports to EU (declining by 0.1% p.a.). Trade with non-EU countries is more balanced, but with imports growing more slowly than from EU (2% p.a. compared to 3.4%) the EU is steadily increasing its share of UK imports, while providing a diminishing market for UK exports.

This pattern – repeated across multiple UK trade sectors – is counter-intuitive. UK should derive some benefit from participation in the Customs Union. Tariff rates for trade in machinery are low, in the 2–4.5% range. But the low EU tariff still gives UK producers an advantage against, say, US-made earth-movers, tractors and excavators. And Single Market regulation should have eased access for UK-made products, for example by creating common safety standards in the design and manufacture of machine tools. And then there's the procedural argument (now used in reverse to justify avoiding a No Deal) that pre-authorised market entry via the Single Market must expedite exports or at least give UK companies preferential or lower-hassle-cost access to EU markets.

Yet the theoretical benefits fail to show up in practice. In 1998, the export of machinery was UK’s second-biggest export earner. The UK exported more machinery than motor-vehicles (£18.4 billion as opposed to £16.2 billion),and UK generated a modest £460 million surplus in its trade with the EU. From the standpoint of 1998, the UK's machinery manufacturers should have looked forward to healthy growth in the EU's industrial markets, to which they had preferential access. But twenty years later, the UK’s EU trade has been comprehensively hammered. Exports have fallen in real terms, while imports have displaced domestic production, rising from £8.5 billion to £20 billion and creating a £7.2 billion deficit.

But the oddity is that outside the EU and trading largely on WTO terms, UK machinery exports have performed reasonably well, growing 2% per year. Today, the UK sells substantially more machinery to countries outside the EU: £17.6 billion to £12.9 billion. As is typical for UK's industrial sectors, the proportion of exports UK sells to the EU has dropped briskly, from 49.4% to 40.6%, while the proportion of imports the UK purchases from the EU has risen, from 54.8% to 60.4%. For whatever reason – or reasons – the UK is globally competitive in machinery goods, just not particularly in the EU. And while the UK isn't benefiting from current arrangements, the EU quite clearly is.

And whichever way you look at the 20-year data, the effect on UK is the precise reverse of what UK companies would have expected back in 1998.

Importantly, the trajectory of UK’s deficit with the EU is consistent, and that is the most critical aspect as UK considers its options. If the UK does negotiate a trade deal with the EU that replicates current arrangements, the logical outcome is that UK’s exports of machinery to EU will continue to gently fall, while imports rise briskly. The sectoral UK‒EU deficit will likely reach £10 billion within the next five years. In other words, UK machinery exporters will gain nothing, while the EU quitely corners the UK market in machinery.

One explanation for UK’s poor performance is that the UK is simply in the wrong Customs Union. Germany is home to the world’s leading machinery-manufacturing companies and so it’s unsurprising that UK is being systematically outcompeted whilst in it. But then, when UK does have a competitive advantage – say in aero-engines – the result can be even worse. This implies that there are various, different reasons for stagnation or decline in UK exports to the EU, depending on the sector. This in turn implies no simple remedy.

4. Chemicals

With exports of £30.7 billion, trade in chemicals is UK’s fourth biggest — but only just. An unusually poor year for UK pharmaceuticals exports saw fourth and fifth spots change place in 2017. Once 2018 is done, the chemicals sector will likely settle more permanently into fifth place. The reason is that this is a shrinking sector for UK trade, partly owing to the long-term decline in UK oil production. Almost half of all UK chemicals exported are petrochemicals (£11 billion), and this segment has fallen in value since 2011 along with UK oil production, though it may rise again if UK’s 2017 increase in oil production proves not to be temporary.

Nevertheless, with an EU export share of 58.7%, UK’s trade in chemicals is one of the few in which Europe still predominates in UK trade.

However, a 20-year analysis shows that UK’s trade in chemicals follows the familiar pattern: that imports from the EU constitute the fastest element of UK‒EU trade, and the slowest element is exports in the opposite direction. Since 1998, exports to EU have grown at just 0.7% per year (in 2015 prices, they were £13.1 billion in 1998 and £15.7 billion 18 years later) while imports have grown by 2.7% per year, turning a surplus of £700 million in 1998 into hefty deficit of £3.5 billion in 2017. Meanwhile exports outside the EU has grown modestly by 1.5% per year, delivering a £2.7 billion surplus in 2017.

Here again, membership of the Customs Union offers indifferent advantage to UK. The common external tariff for hydrocarbon chemicals ranges from 0–5.5%; while paints and fertilizers are higher at 6.5%. Not great, but sufficient to provide a theoretical advantage for UK companies. But the theory refuses to translate into practice. If tariffs are a barrier to trade in chemicals, how come UK exporters are selling 29% more by value to non-EU countries than they were 20 years ago, while exports to EU are just 12% higher? Why is the EU’s share of the UK import market rising (now 72.3%), while its share of UK exports is falling (58.8%)?

Or, to be brutal, how come UK is more successful at selling bulk commodities that are hazardous and costly to transport to countries outside of the EU than in it — especially when a single market regime exists, the specific purpose for which is to make trade seamless in UK’s proximate markets? These are pertinent questions. The pattern of UK trade in chemicals undermines the assertion that bulk goods find natural markets close to home. And it also undermines the gravity economic models used by economists and Treasury figures to forecast UK growth outside the Customs Union.

5. Pharmaceuticals

Next comes pharmaceuticals—the star performer in UK’s goods trade since 1998. Worth just 4.1% of UK manufacturing exports in 1998, the sector has expanded rapidly, and by the end of 2017 accounted for 9.3% of UK manufacturing exports. This is spectacular growth – the fastest of any of UK’s top-ten manufacturing export sectors – generating £28 billion in annual exports by the end of 2017. And while annual growth is still faster outside the EU than in it – 7.5% p.a., as opposed to 6.3% – at least there’s one sector of UK manufacturing exports that prospers within the Single Market.

At least, it did until precisely nine years ago.

Sometime between 2009 and 2011, UK exports suddenly faltered, then fell, and have never fully recovered. Adjusting for inflation, exports to EU were still lower in 2017 than in 2009. Meanwhile, at exactly the same moment, imports from the EU took a huge adrenalin shot. In the space of just six years, fast-rising imports from the EU have opened one of UK’s worst sector deficits, now £8.8 billion. Incidentally, UK’s non-EU exports also took also took a hit in 2011—2014 but recovered. By the end of 2017, non-EU Exports stood at £14.8 billion, surpassing EU exports and generating a £8.2 billion surplus.

Take a slow walk around the statistics and it transpires that the decline in exports to EU coincides with a spate of factory and research-centre closures. Just as with UK’s motor-vehicles production, this implies net investment is shifting away from UK to the EU. Among these dis-investments: Pfizer's 2009 closure of its Viagra-creating R&D centre at Sandwich; Sanofi’s 2012 closure of its Newcastle plant; and Novartis’ 2014 closure of its Horsham factory.

Industry insiders claim that lower corporation tax in Ireland has enticed pharmaceutical companies to relocate. And to take another stroll around the game of trade, a brief reconnaissance of Ireland’s trade statistics show that the Republic has sprouted an enormous pharmaceuticals industry, which now contributes a staggering 29% to that country’s physical exports[4].

And so, for UK’s fastest-growing export sector, the impact of EU membership has been mixed. While UK-based production may well have benefited from a single licensing regime (the European Medicines Agency) from its founding in 1995, the trade data clearly show that 2009 marked a decisive, negative, turning point. It’s the familiar sickness with a later onset. One of the causes may be lower corporation tax rates in Ireland, but the essential point is that the Single Market is now achieving nothing for UK-based pharmaceuticals manufacturing.

And the same applies to the Customs Union but for different reasons. Since the Uruguay Round, which concluded in 1994, all major developing economies have removed tariffs on end-user pharmaceuticals, Japan being the last major, advanced economy to do so. Consequently, UK-produced pharmaceuticals do not currently access EU markets on preferential commercial terms. Neither will UK need to sign fresh trade agreements to trade to best advantage with any developed economy outside the EU.

Compliance is a different matter, since the EU can always choose to not recognise UK-made products. But that is a tactical decision for the purpose of gaining negotiating advantage, or regulatory protectionism, or simply the expression of a desire to hurt the UK economy. By forcing a UK exit from the European Medicines Agency without agreeing a replacement mechanism to authorise UK-made pharmaceuticals, the EU would certainly create a short-term barrier to sales. But this would constitute an act of economic aggression against the UK, to which the UK would have to respond accordingly. It would not be a permanent trade arrangement.

Analysts have only to observe the spectacular growth in UK pharmaceuticals exports to countries outside the EU – growing at 7.9% p.a. over 20 years – to conclude that participation in supra-national drug-licensing agencies are tangential to export growth. Otherwise, how could UK exports of pharmaceuticals grow faster where there is no benefit of automatic product-standards recognition, than where there is?

More broadly, if pan-national licensing is vital to industrial efficiency, how could Singapore, population 5.5 million, have created one of Asia’s premier pharmaceuticals and medical technology hubs, manufacturing approximately S$17 bn of pharmaceuticals per year?[5]

If UK wishes to reverse the decline in exports to EU since 2009, however, then reverting to WTO rules is unlikely to achieve anything by itself. This will probably require government intervention to re-attract so-called ‘big pharma’ back to the UK; possibly through lower corporation tax rates, if that's what lured them to the Irish Republic after 2009. But if nothing changes in UK’s current trade arrangements in pharmaceuticals then an £8.8 bn EU deficit will carry on growing ultra-quickly as global investment slips abroad. This means, in effect, the UK becoming increasingly dependent on medicines imported from the EU.

A continuation of this trend would mark a cardinal failure for UK trade and UK trade policy. In the one industry where UK indisputably possesses world-class expertise, world-class research, world-class academia, a highly skilled work-force and a superb record for growing global exports, UK would have to stand and watch its exports stagnate in Europe’s ultra-high-value health markets, while low-corporation-tax-incentivised companies relocate from UK, then make vast profits from supplying a three-quarter share of UK’s rapidly growing import market.

Verdict on the Top 5, or 50% of UK goods exports

At this point, it’s worth reviewing the proportion of trade already covered. These five sectors – motor vehicles, transport equipment (i.e. aerospace), machinery, chemicals and pharmaceuticals – account for 56% of all UK manufacturing exports, or 50% of all UK goods exports. But the critical point is this: collectively these five sectors are becoming more important to UK trade. In 1998 they accounted for just 42% of all UK goods exports. These are, therefore, the manufacturing sectors that most matter to the future of UK trade.

Consequently, the trade arrangements the UK government negotiates for these five sectors will largely determine the success of UK’s future trade with the EU. The current UK government is trying to replicate the benefits of UK's tariff-free trade and Single Market access for these sectors, yet analysis of trade since 1998 indicates that UK gains no discernible advantage thereby. Since 1998, expansion in these five sectors has been driven solely or predominantly from growth in non-EU markets.

To recap: in motor vehicles, UK’s export renaissance is solely due to spectacular growth outside the EU while inside the EU exports have not materially increased since 1998; in aerospace where UK exports have grown well, the Customs Union is irrelevant and UK trade is anyway already thoroughly globalised and governed according to global rules; in machinery, the familiar pattern emerges of zero export growth, combined with brisk EU imports creating an ever-expanding deficit; in pharmaceuticals – UK’s fastest-growing sector – exports to EU are now in decline and a huge trade deficit is opening up; while exports of chemicals are largely a function of UK’s petrochemicals industry anyway.

In none of these five sectors – again, half of goods exports – does UK currently accrue any obvious advantage from the trade-related aspects of EU membership because either exports have stagnated, or growth is clearly owing to something other than the Customs Union and the alleged benefits of the Single Market. What UK has gained, in four out of five cases, is massive deficits.

The peril of UK’s position is that if Brexit replicates existing trade arrangements, then UK will lock in conditions that either perpetuate or precipitate the capture of UK markets by EU producers in return for near-zero-export growth, a defining feature for three of these five sectors over the past two decades, and for a fourth (pharmaceuticals) since 2009. This might be to UK’s advantage if, in return the UK retained or gained access to services markets of a similar size. But the numbers don’t stack up.

Even if analysts attributed the whole of UK’s financial services surplus to the benefit of the single market (which no-one would), it is nonsensical to see the gains UK makes as proportionate to the deficits the UK now incurs in its biggest, goods-export sectors. So far as the UK is concerned, the Customs Union and Single Market have not operated as a free trade area should since at least 1998. What UK has gained, it would have mostly gained anyway; what UK has lost – in terms of stagnant exports and rocketing deficits – has occurred within the Customs Union and Single Market.

Thus, even a UK‒EU trade deal that preserves current access for financial services is hopelessly imbalanced from UK’s perspective. And a trade deal without access for services would be penal. Worse, continued membership of the EU Customs Union throughout the transition period means UK will bear the opportunity cost of not liberalising trade with its fastest growing markets for a further 20 months after the date when Brexit officially occurs. The worst aspects of UK’s EU membership would be preserved – and possibly set in stone – while the greatest opportunities of Brexit will be postponed.

What would a 'No Deal' mean for UK’s top-five goods sectors?

Would a ‘no-deal’ achieve better results for these five sectors? Here the question depends on two factors: the regulatory aspects of customs, and UK’s long-range trade policy. First, if the UK leaves without a deal, then the EU can, if it chooses, block UK products and services by simply refusing to agree to recognise the relevant licences and standards or protocols, or by refusing UK participation in the relevant agencies.

But such an act is separate to establishing new terms of trade. The EU routinely makes agreements with third-party agencies around the world, so EU consumers can purchase goods and services from those regulatory jurisdictions. To threaten to block the importation of UK products and services via a refusal of regulatory collaboration, however, is to try to use Brexit as a source of leverage in negotiations to gain advantage, either in exit payments, or preferential access to UK markets.

The fact that EU has chosen to negotiate in this manner is instructive. To exploit UK dependence on, say, the relatively new European Aviation Safety Agency is to signal to UK that it its commitment to such agencies is going to be used as a source of leverage, and not, principally, as a convenience for the benefit of European airline customers or flight operators. Thus, the way that the EU has chosen to negotiate in itself pushes UK towards total regulatory separation from the EU, since it clearly sees regulatory compliance as a tactical tool in trade negotiation.

Considering the EU’s stance, UK’s safest option is probably to re-establish regulatory autonomy as fast as possible, regardless of the cost. This applies in particular to aerospace and pharmaceuticals, because those are the sectors where UK is now being subjected to pressure. In the unlikely event that UK feels nervous of re-establishing regulatory capabilities that were ceded only a decade ago, either Canada or Australia would serve as role models.

If EU does follow through and withhold recognition of UK goods and services that it currently accepts, then UK needs to recognise that it is being subjected to hostile threats and respond accordingly. Rectifying that confrontation may take time and may incur severe disruption, but it will not affect the basic balance of advantage involved in choosing either to continue to provide the EU with preferential trade terms that resemble current arrangements, or alternatively trading with the EU on WTO terms, or abandoning the policy of imposing customs on all or most goods imports.

The second factor affecting UK’s potential success with WTO rules is its commitment to free trade. If UK chooses a cautious approach, and eventually settles on a policy of negotiated tariff and barrier reductions – especially in food – then a no-deal UK would probably replicate the current, EU Common External Tariff (CET). Costs would certainly rise for consumers, in particular for motor vehicles and for food.

Alternatively, the UK could move decisively and unilaterally towards free trade by eliminating or drastically reducing tariffs in its new, independent WTO schedule. Although radical, this strategy would involve least disruption to UK consumers and lower costs — particularly in food. While appearing drastic, it would also carry the least risk of disruption, because it would simply eliminate many of the tasks required of HM Customs & Excise [6]. The UK might also consider a 'Free Trade with Deterrents' approach, eliminating tariffs on all but a few goods where collection would be easy and sufficiently penal (i.e.valuable) to enable UK to retain negotiating leverage over the EU. A 10 or 20% tariff on luxury motor-vehicles, for example.

No Deal: fewer long-term risks than preferential trade

But there’s one thing UK should not fear in the event of a ‘no-deal’ — a drop in business investment. The deficits in four of the top five sectors analysed thus far are the result of pronounced, long-term shifts in investment from the UK to continental Europe within the Customs Union. The deficits are the irrefutable evidence that during UK membership, investment has, on balance, moved overseas, with businesses using the seamlessness of the single market to import freely back into UK. A ‘no-deal’ would instantly reverse this trend, because companies that did not re-invest in UK would have to face the risk of losing market share, if UK did replicate the EU's current WTO tariff schedule.

Take a practical example: motor vehicles. The UK has a £28 billion deficit in vehicles and parts precisely because car companies have, net, increased their supply of vehicles to the UK market from continental car plants since 1998. The current deficit is the physical result. If UK was, net, attracting more investment under the single market, then the deficit would be declining, or the UK would already be in surplus.

In the event of a no-deal, if UK replicated the existing EU WTO schedule, it would impose an average 9% tariff on car imports and potentially a 3% tariff on some parts. The result: car manufacturers would have to switch investment back to UK to stay competitive (or resupply from a zero-tariff location, such as South Africa [7]). In the short-to-medium term, the UK would likely become home to Magna Steyr plants producing vehicles under licence for Volkswagen, BMW and Mercedes.

The medium-term outlook is, however, fundamentally impacted by the EU-Japan Economic Agreement, which will come into force in early 2019. Why a deal so transparently prejudicial to UK car manufacturing received next-to-zero critical attention is a mystery, especially when concern for UK car manufacturing appeared one of the principal drivers of debate on UK's future trade ties with the EU. Whatever the UK does, these car plants are likely to cease to attract export-oriented investment, as each company re-casts its long-term strategy for selling into the EU. They have, in any case — and as the data show — scarcely lifter their export game in 20 years.

Consequently, one of the biggest dangers asserted by opponents of a No Deal — that it would threaten the exports of Nissan, Honda and Toyota — has been dramatically overtaken by events. The EU trade negotiation team has already traded the commercial advantage they currently enjoy in the EU in return for greater access for EU producers of agriculture, food products and particularly beef to Japanese markets. By an ironic turn, the only act open to UK governments likely to keep those plants competitive in the medium term is for UK to replicate the EU's current 9% tariff on motor vehicle imports, and drive a competitive advantage for those cars into the UK car market, and then see how they compete as purely domestic producers.

Similarly, a WTO tariff-replication strategy would also find Jaguar-Land Rover selling at a competitive advantage in the UK, since its German competitor models would all be entering the UK market at higher prices. What's more, the UK would, on balance, become a more attractive global export base in which to invest, because the imminence of trade deals with major economies such as US, China and India would open the prospect for JLR to export to those countries for free — which is almost inconceivably unlikely if UK were to remain within the Customs Union.

But the essential point is obvious. Falling back on WTO rules for UK’s EU trade would provoke opposition from global manufacturers who could no longer coerce European governments into giving them handouts to relocate production elsewhere in the EU. And the car manufacturers that stood to lose out most — Nissan, Honda and Toyota — are about to re-think their global manufacturing strategies anyway. But if UK, even as a starting position, simply replicated the existing CET for imports into UK, the net result would be to force investment back into UK in the motor industry, and in the machinery and chemicals industries, because these are the sectors where global tariffs apply, and it's also where UK has large and growing deficits with the EU.

Admit the failure, then move on

Of far greater concern are UK prospects if the country either stays in the Customs Union or replicates current arrangements. Twenty years ago, UK‒EU trade was balanced. Since then UK exports have stagnated, while imports have risen by over 3.3%. p.a. Ominously, the average value of UK manufacturing exports to EU was lower in the last decade (£122.2 billion for 2008 ‒ 2017) than in the previous £128.6 for 1998 ‒ 2007) . This means the UK is in the embarrassing position of negotiating for a trading arrangement that is ever-so-gently throttling UK exports, either through ignorance of fear of the short-term consequences.

Which brings us back to the central consideration for a UK‒EU trade deal. Before agreeing to one – or negotiating away diplomatic capital in pursuit thereof – the UK should seek to understand precisely why it fails to benefit from the Customs Union and Single Market. This analysis shows that it isn’t because the UK is uncompetitive: motor vehicles and pharmaceuticals constitute a growing share of UK exports, and are expanding their global markets. Neither is it because EU economies grow more slowly than non-EU economies, as is clear from data on motor vehicles and aero-engine exports.

And since the United States has enjoyed robust goods-export growth into the EU over the same period, the question is wide open to imaginative answers. But there is no way of comparing UK's export record inside the Customs Union since 1998 with any other measure of trade or market or labour productivity growth, and judging UK membership to be an asset.

Failure might be due to differences in the culture of compliance, or the mischance of being in a customs union where the UK’s most competitive products gain no advantage. It may simply be that Customs Union and Single Market are most impactful where German industry is most competitive – in motor-vehicles, machinery and chemicals and the UK is on the receiving end. Maybe UK's representatives in Brussels have done a poor job at moulding the Single Market in UK's industrial interests.

Or it may simply be a matter of taste. Perhaps UK goods will never be popular in European Markets and the past 20 years proves that now is the time to stop trading with the EU on preferential terms. But whatever the cause, something went terribly wrong with UK’s trade within the EU well before the Brexit vote. Brexit is the opportunity to correct what’s wrong. To perpetuate preferential terms of trade that benefit other EU economies but not UK is heedless folly.

...Part 3


* The average for UK's non-EU exports currently traded under WTO terms is 73% (See UK Trade, Goods & Services, Tab 1, Section 2) although the figure is higher for the majority of the period 1998 to 2017, as more EU-negotiated FTAs have come into force. The proportion of UK motor vehicles and parts exported on WTO terms is best gauged from a perusal of the annual reports of premium car companies, which are UK's principal non-EU auto exporters. For example, JLR's 2016/17 annual report states that North America takes 20% of sales, China 21%, the UK 21%, Europe 20% and Other countries, 15%. Europe will account for over half of the non-EU trade on which UK trades on non-WTO Terms (owing to EFTA). Consequently, most of the last 15% will be WTO-type trade. This means that (very approximately) over 75% of JLR cars are likely to be sold into countries with which UK has no trade agreements. However, JLR also manufactures overseas, principally in China and Brazil, but also Pune, India. Consequently, the proportion is likely to be lower. Until better analysis established average for UK exports of 73% of non-EU trade being conducted on WTO terms looks representative of the UK auto sector.

[1] In a recent edition, The Economist implied this factory’s existence was consequent to the Brexit vote. It isn’t, since the decision to create a factory was announced in 2015. It did, however, receive over one hundred million euros of state aid from Slovakia, which was subsequently approved by the EU Commission itself in 2017.

[2] See:

[3] For example, Trading Economics.

[4] As of Q3 2017. See the official publication: Ireland Trade Statistics, November 2017. pp 30.

[5] The Singapore Ministry of Trade. See: and Robert Walters

[6] Ambrose Evans-Pritchard, who writes for the UK Daily Telegraph, now views this as UK’s best option.

[7] With respect to vehicles, the prospect of UK inheriting the existing FTA with South Africa is of particular interest. Mercedes at East London, BMW at Rosslyn, and Volkswagen at Uitenhage all produce right-hand drive vehicles for export. Thus, if UK adopted a default No Deal strategy with the intention of encouraging re-investment in UK motor-vehicle production, it should be cautious of rolling over the existing FTA with South Africa.